Chapter 16

Unemployment and Inflation: The Phillips Curve

IN THIS CHAPTER

Understanding the short-run trade-off between inflation and unemployment

Looking at why this trade-off disappears in the long run

Recognizing the role of expectations in determining the effects of macroeconomic policy

Thinking about policies to reduce the long-run natural rate unemployment

Confession is good for the soul. At least St. Augustine thought so. And he wrote the book on confessions. Ahem, we have a small confession to make. Well, it’s more of a qualification or perhaps an extension than a confession. But we still feel good about it.

The qualification is that our AS–AD model discussed so far in the book is a bit incomplete. Why? Because the vertical axis variable is the price level P. That’s not a bad thing. But it’s a different thing from the rate of change of prices, that is, inflation π. This means that as we’ve presented it, the model can talk about P and even how P might change as we move from one equilibrium to another — but we haven’t yet told a story about why prices keep changing steadily even in equilibrium, or how the rate of change might be different depending on where the equilibrium is.

In this chapter, we talk a lot about inflation and the state of the economy. This can be worked into the AS–AD model. It’s a little awkward, but that’s where we’ll start. Later we talk about how inflation can be related to the degree of economic slack as proxied by an unemployment measure and why ...

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